On the call: Sharmin Mossavar-Rahmani, the Chief Investment Officer of the Investment Strategy Group and Judd Gregg, the Former Republican US Senator from New Hampshire and Chairman of the Senate Budget Committee.

BACKGROUND:

There is some debate as to whether August 2nd is actually the deadline.

We reached the statuatory limit on May 16 and the government has been using measures to avoid a default.

On August 2nd, the government will run out of cash.

On that day, the government has to send out social security checks. It might not be able to afford it.

At issue: We owe tons of money. The U.S. debt-to GDP ratio is expected to be close to 100 in a few years.

Ratings agencies are talking about downgrading the U.S. which is significant. Unless it's a significant number, S&P will lower the U.S. rating. The longer it takes, the more likely S&P is to downgrade the U.S. rating.

The Treasury has estimated that we need a $2 trillion increase.

11:11 Gregg is on the call now.

11:12 In the Senate, you've got a center of 40 members who are willing to sign on to something dramatic AND you have the President endorsing it -- that's good news. We have agreement on the problem and a resolution

11:14 BUT the house is nowhere near an agreement. The gang of six plan will not come to fruition in the next few weeks - maybe not even until the next election. The best thing that could happen is that a special committee might be set up to continue to work on the gang of six agreement. Ultimately, it won't affect the debt ceiling debate in the short-term

11:15 The Mcconell-Reid is too political, people say it's a fallback, I think that's wishful thinking

11:16 The most viable: a group comes together to make cuts and somehow, Boehner and Cantor get a majority of the Rep members to vote for a smaller reduction in spending in exchange for a smaller reduction in spending. Or maybe they kick the can down the road for the next few weeks because they're able to say they're making progress. Hard to see that being the action unless there really is a coming together that's visible between Boehner and the Pres

11:17 My gut tells me that we'll need a weekend of drama - maybe a weekend of the government not paying its bills - politicians need drama to make something happen. As soon as social security checks don't go out, the politics will change. I suspect itll take artificial drama to get closure past the house.

11:19 Boehner understands that a shutdown is bad for his caucus and that there's something viable short of a shutdown but right now... it's a 50-50 chance that we go into a few days of disruption

11:20 Policy-makers only worry about a ratings downgrade at the margins. They dont really care. The ratings agencies put themselves in a corner that's foolish. I've always found them to be incredibly naive about the political process. To be so definitive is foolish

11:22 Ratings agencies to make this drop-dead date, its stupid and naive because we'll straighten it out but our process doesn't allow it to do it overnight

11:23 Now Alec is on the call.

11:23 It has to do with the magnitude of the downgrade. If we went to AA, directionally it would be negative but it's suprising the modest effect it could have on, IE:

-- Money market mutual funds are front of mind when thinking about a downgrade. Reqired to hold 97% of their assets in AAA

In terms of the rating that matters - it's the short-term rating, not the long-term rating. And the S&P has implied that it would only downgrade the long-term, so money market funds wouldn't be affected. They hold between 300 and 350 billion in treasuries. Probably not as much of a risk

-- Financial sector- banks -- didn't want to be too specific, but under Basel I there wouldn't be any affect. under basel II, 0-risk to anything AA and above, so not really an issue

The complicated factor comes in with some of the larger firms, there could be a slight uptick in the calculated capital required to be set aside related to holdings. But a very minor change in capital requirements

-- Insurers - obvious. those three bring the $ up to $1 trillion

-- Pension funds - not much of an issue

11:28 Rest of the question becomes what the rest of the world would do, how much selling, but they might have more flexibility than holders in the U.S.

11:31: On august 3rd we have a social security checks due. On August 15, we have a coupon due. The treasury will have to decide what it will do to make those payments

11:33 Gregg is back on the call. Not sending the social security checks would change the politics of this thing. I wouldnt be at all surprised if the treasury made the decision. That would put the blame on the republicans and change everything. Hopefully they're trying to reach some agreement and who knows what the dynamics will be

11:34 I think the odds of having a government shut down are at least 50-50

11:36 GOLDMAN on the call: In the past when shut-down happened, the market impact of the cases was somewhat muted

11:37 But it's hard to think it would be a nonissue if the S&P were to downgrade

11:37 Alec is back on the call

11:38 On the effect of a shutdown on the market: obviously it's a negative event. In terms of long-term views of the risk of holding treasuries based on the 95-shut down - it had a continued effect

11:40 If you look at what happened yesterday, the equity market does seem to be interested in a resolution, it could be that the path to reach that is less important than getting there

11:41 Gregg is back on now, talking about how the blogosphere is changing things because now we're hearing loud voices speaking about their views, instead of rational voices, which don't get as much attention

11:44 I'm still optimistic that rational voices will be heard

11:45 A small increase in the debt ceiling in exchange for a small decrease in spending (temporary) is most likely deal to happen

11:46 After the next election, there will be major tax reform, major changes to defense spending, and changes to Medicare

11:47 If the election were today, the President would have a problem. Something like 70% of Americans think we're on the wrong track right now

11:48 Senate will probably go Republican, I dont know what happens in the House

11:49 At some point, there will be a real reaction by the markets that our debt levels are not sustainable and we're running out of time here and no matter what happens in 2012, we'll have to deal with it

11:50 Whether there's a big drop in the dollar or the market first depends on who's in office

11:52 The call is over. Goldman says it shares Gregg's long-term optimism but believes there will be some short-term volatility and recommends that given the inability to predict what will happen, portfolios are able to sustain a lot of volatility